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Published: Mon, 17 Apr 2017

Income inequality is a word that used to describe an income of a defined geographic area disparity distribution of wealth, “The poor become poorer, the rich become richer”. For further explanation, income inequality means that a small number of people living in defined area receive the most part of the total income generated, while most people receive only a small share of the total income. If the gap between high income and low income households is getting higher mean level of income inequality is higher. Pie chart above is an example of income inequality, showed 90 people taking only 20% of total income and only 10 people taking 80%, the big part of total income.

Income inequality measurement tools

There are several of different tools and strategies used to measure this type of economic disparity. Few of the popular methods are Theil’s index and Gini coefficient.

Theil’s index base is 0 which also for perfect equality and got no upper bound. Theil-index has the advantage that more concentrations on different subgroups like races or regions in the country, but it lack of appealing interpretation as compare with the Gini coefficient.

The Gini coefficient, named after its inventor, the Italian statistician Corrado. It’s a standard economic indicator to measures the inequality of income distribution within a country. Base of the Gini index is 0, which indicate perfect equality, every household have exactly the same income. The higher the number, the higher the inequality and the score of 1.0 indicate perfect inequality where a single household has all the income. The Gini coefficient can be easily represented graphically by observe the area between the Lorenz curve and the line of equality. If the income distribution is total equality, the income distribution curve would be the straight line in the graph as 45 degree which is the equality line. As income distribution more unequal, Lorenz curve bows out more and area A becomes larger and area B becomes smaller. When income distribution is perfect inequality, the Lorenz curve will pass through the points (0, 0), (100, 0) and (100,100). [1]

Equality line

Lorenz curve

Charts above show example of normal inequality and perfect inequality.

Calculation, the Gini coefficient = areaA (areaA+areaB)

Cause of income inequality

Income inequality is caused by uncountable factor, below are just few of the cause of income inequality.

Demographic

One of the reason of income inequality is because of most of the high income household has a same characteristic, which is have two worker. Then, household with only have one income are mostly low income household but this doesn’t mean all household with single income are poor. Moreover, Upper or lower class people tend to marry the same class people. Therefore, those married upper class household will have two high income workers, then by analogy the lower class household will have two low income workers. Even more, single parent family tend to be an important cause of poverty and income inequality especially when there are only woman as the family economic pillar.

However this also shows that gender is another cause of income inequality. According to the Labour Department’s Bureau of Labour Statistics, 2003, for every dollar that a man makes, a woman makes about 80 cents and ages between of 45 and 54 women make only 73 cents for every dollar men make. [2]

Education

Education is one of the greatest causes in income inequality. Every generation of Americans appear to have a better education level than previous generation, which mean average adult should have more education than their parents. In America’s history, first time that the current generation is not significantly more educated than previous generation. [3] Currently, it’s obvious that college or university graduates have better paid which much higher than high school graduates workers as showed at figure 1. So, it also meaning that higher education level or worker with better skill gives better wage. This situation has pushed the current generation, especially in Asia, to get into top colleges and universities with a goal to get premium wages. [4]

Technology

Technology is widening the gap of poor and rich, rising income inequality as it replaced so many worker at factory job, while more complex operated machine required better skilled worker. This cause solely explains the increase in the Gini coefficient since early 1980s. [5] As technology getting advance, demand of skilled labour increase and non-skilled labours will replace by machine and skilled labour. Therefore, the low wage labour forces appear as the supply is more than demand. For example, cheap labour forces from low income, high growth rate country, China and Bangladesh.

Does income inequality matter?

Why income inequality matter? Answer is because it is unfair. For example, 5 people sharing 100 dollar, while one person get 80 dollar and the rest get only each person 5 dollar? Most people won’t able to accept that. According to Freeman, Richard B., we should put effort on income inequality problem as Freeman mentioned in “Solving the New Inequality.”(1999), “falling or stagnating incomes for most workers and rising inequality threaten American ideals of political “classlessness” and shared citizenship. Left unattended, the new inequality threatens us with a two-tiered society-what I have elsewhere called an “apartheid economy”-in which the successful upper and upper-middle classes live lives fundamentally different from the working classes and the poor. Such an economy will function well for substantial numbers, but will not meet our nation’s democratic ideal of advancing the well-being of the average citizen.” [6]

How does income inequality affect a country’s economic and social developments?

Generally, income inequality brings negative effect. Income inequality could affect a country’s economic and social developments.

In term of social developments, income inequality will increase the crimes levels. As the low income workers feel unsatisfied and unfair, they temp to commit a crime to get extra incomes or release their unsatisfied feeling. Income inequality might affect health of a country. Reason is low income worker having not enough money to get a better medical support or better health care. Additional, education of low income worker and their next generation will be limited too.

Referring to the case study of income inequality in Singapore (Ishita Dhamani, n.d.) [7] , income inequality would lead to racial instability. There are three main races in Singapore, Chinese, Malay and Indian. According to the case study, Malay mostly comes from low-educated and low income families. Hence, most of their younger generation perform poorly in education and end up with working with low income job. In result, the Malays are difficult to release from the low income phase. In fact, government has provided a lot of additional benefit for them. If this continues happen, Malays will drop into poverty category and getting left behind by the society. In additional, there are potential that riots in the multi-racial may happen. For example, May 1998 riots in Indonesia, which Chinese Indonesian discriminate by the local Muslims.

In term of economic developments, an excessively equal income distribution can be bad for economic efficiency. Then, income inequality will lead to a country poor discipline, and the low income workers which also less skilled will have low quality and performance may cause country’s economic growth slower and leading to more poverty.

High level income inequality will threaten a country’s political stability because more people not satisfied with their income. Then, political instability of a country will significantly undercuts its development potential. (Income Inequality, n.d.). [8] Furthermore, high income inequality will affect the reputation of a country. So, investor and others country will think twice to invest in that country.

In summary, income inequality generally brings negative and bad effect to a country.

Ways to combat income inequality

As income inequality gives negative effect, it needs solutions to stabilize it. First, introduce minimum wage policy. Government should have minimum wage for protect the employee instead of increase the tax rate to lower down the income of rich people. In additional, policy can include that employer require to have a contract with employees to ensure their benefit. The minimum wage will be the wage floor, which employer is not allow to pay less than the minimum wage to his employees. This will able control the market wage rate to ensure every employee has at least a basic income. Therefore, people who work will at least able to live in a basic standard life. Moreover, performance of employees will increase too when they receive more in return. However, minimum wage have disadvantage too. After introduce the minimum wage, higher wage companies have less motivation to hire workers. Then, more labours will be attracted into the workforce. Meanwhile, disequilibrium will occur where labour demand and labour supply unequal and unemployment rate will increase.

After introduced minimum wage, no doubt educations will be the most important ways to combat income inequality. Technology and education are several of the reasons of income inequality. The best solution for both causes is give better access to education. Better access to education will allow those low income worker and their children easier to have better education level. When workers have better education and skill, they will be skilled and qualified to get better job that give higher incomes. However, policy maker shouldn’t overstate the potential of education because this only will give people have the equal chances to compete as they have the same education level.

Summary

Income inequality is word that used to describe an income gap of the poor and the rich of a defined geographic area.

Two of the common methods used to measure income inequality are Gini coefficient and Theil’s index. Gini Coefficient rating the income inequality from 0 as perfect equality and 1 is perfect inequality. Gini coefficient can be efficiently present in graphic by measuring line of equality and Lorenz curve.

One of the causes of income inequality is demographic. The same classes’ income people tend to stick with the same classes people. Then high income household generally receiving double income as two people is working. Gender is another cause of income inequality, female’s income generally less than male worker. The greatest cause of income inequality is education and technology. College graduated worker receive higher income than secondary school graduated worker. Technology has replaced many workers at factory job and skilled worker are required to operate the machine which caused unskilled worker stay unemployment.

Income inequality is unfair. Income inequality will affect a country’s social and economic developments. As the income inequality level higher, the crime level will be higher, health level will be unhealthier and education level will be lower for the low income families. Income inequality might spark racial instability, for example, May 1988 riots in Indonesia.

Income inequality will slow down the country’s economic growth and more poverty as the citizen has low standard and performance. Then income inequality will cause political instability, and the country economic development will be undercuts. Moreover, it may able to affect the reputation of a country.

Minimum wage policy is one of the solutions to combat income inequality. Minimum wage policy able to control the income equality, reduce the poverty and ensure the employees at least able to live in a basic standard life. There are negative effect of minimum wage policy, high wage companies will lose motivation to hire worker, disequilibrium will occur where labour demand not equal to supply, and unemployment rate will increase. Giving better access to education is another solution, where all people can have better education and have equal chances to get a same level wages.

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